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Zone pricing ban coming to New York, will the results affirm policymakers’ hopes or economists’ analyses?

New York is about to find out whether zone pricing in gasoline markets is as bad for consumers as some people believe. Zone pricing is “a gasoline industry practice of selling the same brands and grades of fuel to retail sellers at different prices depending on the ‘price zone’ in which the retail seller is located.” (Link) In effect, gasoline wholesalers charge a higher wholesale price to retailers when the wholesaler thinks that the retailer’s consumers would pay a higher retail price. Zone pricing is an example of what economists call price discrimination.

Typically it is more affluent consumers who live in “zones” that face higher wholesale prices, so anti-zone pricing legislation is essentially consumer protection for affluent customers unwilling to spend their time shopping around for lower prices. (Of course affluent people are people too! Their opportunity costs of shopping for lower prices are actually on average higher than the opportunity costs faced by poorer people. Is that any reason they should be stuck paying higher prices? Zone pricing: Unfair to rich people!)

At least it is consumer protection if it actually results in lower prices for the more affluent zones. Here the hopes and dreams of some policymakers appear to come into conflict with the results of economic analysis.

Experimental economics work by Cary Deck and Bart Wilson, published this year in the Journal of Economic Behavior & Organization, finds that zone price bans tended to result in higher wholesale prices in what would otherwise be lower wholesale-price zones, but without leading to lower prices in the less competitive, high cost zones.

In a review of literature on “Retail Policies and Competition in the Gasoline Industry“, UC-Berkeley economists Severin Borenstein and Jim Bushnell suggest that zone pricing will lead to higher prices for some consumers and lower prices to others, overall “it is unclear whether it benefits or harms consumers.” They point out that price discrimination can lead to overall net benefits to consumers even if some consumers are paying higher prices.

A review of zone pricing by the Federal Trade Commission found the effects on consumers to be “ambiguous.” In 2007, the FTC told Connecticut that a bill similar to the new New York law would likely harm consumers because it would reduce incentives to supply gasoline in under served areas.

An article by Christopher Ball, Mark Gius, and Matthew Rafferty, in Regulation magazine, relied upon a earlier version of the Deck and Wilson research to estimate that with the Connecticut policy under consideration in 2007 “the average price at the pump increases and the burden of the increase falls disproportionately on those with the lowest incomes.” The Connecticut legislature did not pass the bill.

But this year New York, with legislators presumably having access to all of these reports, chose to prohibit zone pricing. The bill, S175B (search for it here), was justified by its sponsor as follows:

Zone pricing is a marketing technique currently used by petroleum companies. The company determines geographical price zones based on the demographics of a certain area. For example, if one area typically is more affluent than another, the tank wagon price, in other words, the price per gallon determined by the wholesaler, at which gasoline is offered for sale to the retailers may be slightly higher in that area, than an area where the clientele is primarily a working class neighborhood. Because the petroleum companies increase the amount charged to the service station dealers for the gasoline in those designated zones, this cost is then passed on to the consumers. Thus, the result of zone pricing is higher prices at the pump for individuals who are assumed to be able to pay more. This legislation would prohibit this discriminatory pricing policy.

The law was signed by Governor Paterson on September 25, and will go into effect on November 26, 2008. So far as I can tell, Connecticut hasn’t passed a comparable measure. A fairly clear test of the effects of a zone pricing ban is now in the works. Soon we should see whether, relative to what happens in nearby Connecticut, prices in affluent New York zones fall down to the prices in poorer New York areas, or whether prices in poorer zones tend to rise toward those in more affluent zones.

The bill’s sponsor in the State Senate, Jim Alesi, is from Rochester-suburb Perinton, New York, a locality of higher incomes and lower poverty than most of the Rochester area. But it is out in the much-wealthier-on-average-by-a-long-shot Hamptons, at the east end of Long Island, where folks are most fervently joining in the hopes and dreams of lower prices.

East Enders have been living with gas prices as much as 25 cents to 50 cents higher compared with prices at points further west. When the law restricting zone pricing goes into effect, Hamptons residents can expect to see that margin narrow to somewhere closer to five cents.

Economic analysis suggests that instead, poorer New Yorkers will end up paying a little more in what will turn out to be a mostly futile attempt at providing consumer protection for “East Enders” and other more affluent residents of the state. Margins will narrow, but not in a way that benefits consumers overall in New York.

I predict another victory for the dismal science. Let’s check back in a few months.